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December 20, 2012

Four Rules for Investing in Tech Startups

Doing well in the high-tech industry is no easy feat, for entrepreneurs or investors, according to one expert--but there are ways to increase the odds of success

Tech startups offer an enticing risk-reward tradeoff but if your clients underestimate the risks they’re unlikely to reap the rewards.

"When you’re investing in a startup you’re not investing in the idea, you’re investing in the people that are doing it. The number one thing that I’ve seen kill startups are founders who think their idea is either infallible or not subject to challenge," explains Chell. "They often have their own personality or sense of value wrapped up in the success of the idea and their thinking.

"They believe that what they’re bringing to the table is the idea as opposed to the leadership and the vision and the energy. Ninety-nine point nine percent of startups with those types of personalities are going to crash," the entrepreneur says. "They need strong personalities but they need more than one to create that constructive conflict. So, the number one rule is making sure that the egos are in check."

Rule No. 2: Be sure the startup really understands what it's doing.

There are three broad phases that are very distinct for a startup, according to Chell.

"The first phase is does the startup even have a product that people want. In that phase, money and resources have to go into doing certain things. The next stage is after they’ve determined quantitatively that they have a product that people or businesses want they have to tailor that so they can get it into the market," he shares.

"They have to make that product fit the market and fit the business rules of the customers they’re selling it to. Those resources that they have and are getting from investors need to go into a different set of priorities," Chell points out.

The final stage, he notes, is scaling: "How do you get the product market on scale and meet your margins and that type of thing? That’s a whole different set of tactics that will take up your resources.

"A lot of startups think they have to do everything at once," Chell adds. "They don’t realize that if they’re in the first stage, the most important thing to do is learn. If they’re in the second stage, the most important thing to do is specify what the customer wants. If you’re in the third stage it’s all about how you grow sales and marketing and scaling and those types of things."

Rule No. 3: Know the scope.

"Changing the world is great, and many startups go out there to change the world. But not every startup has the resources to do it. Does each resource fully understand the vision of what they’re trying to create?" asks the entrepreneurial expert.

"Many startups really don’t understand the complexities of why certain things work in the industry that they’re trying to break into. Usually the reason there’s not a better mousetrap is not because other people haven’t thought of it or other people haven’t designed it or other people haven’t built it," he explains.

"It’s because there’s a whole bunch of business rules in the industry eco system that prevent that particular mousetraps from being improved. If they don’t understand that scope of what they’re doing we get really worried," Chell notes.

Rule No. 4: Focus on the team.

"Has the team succeeded in the past? Are they connected extensively with the professional network in the industry or within the sector that they’re working?" inquires Chell. "Quite often if they are, they already understand the other solutions that are out there or the other solutions that they can leverage to make their solution work."

"Is there more than one founder? You know the Hollywood version startup is that there’s one founder and they’re the rock stars but if you look at the data, that’s not true," explains Chell."Even with Microsoft, Bill Gates had Bill Allen; Steve Jobs had Wozniak and Zuckerberg had a whole bunch of people. If there is only one founder, you know what, we get very nervous.

"There is not one person that we have found that possesses all the experience needed to get a new product or a revolutionary disruptive technology to market so we look for companies that have more than one founder. It also tells us that if there’s more than one founder involved they probably already culturally have a way to deal with conflict and a way to work through issues and problems and that whole first problem with ego tends to be much less," he concludes.